ALPHA TO OMEGA: OUR BLOG

As outsourced Chief Investment Officer (“OCIO”) solutions become more popular with institutional clients, the need to compare firms on a quantitative basis grows greater. If you’ve spent any time talking about the OCIO model with Alpha Capital Management, you’ve likely heard us mention GIPS compliance as an issue.

Performance is one important way to draw clear comparisons between investment managers (though, of course, it is not the only factor to consider). Most investment managers in traditional asset classes, especially those who work with institutional clients, claim compliance with Global Investment Performance Standards (GIPS), a globally accepted methodology for calculating and presenting performance information. Prospective clients are able to directly compare investment manager results to measure skill (i.e. alpha). GIPS is not as common yet in the alternative investment space, although that is expected to change in the near future with many hedge funds working toward GIPS compliance. The CFA Institute has been working on a project called GIPS 2020 aimed at improving the standard and increasing adoption, and it is expected to propel adoption of GIPS among alternatives managers. We hope it does the same with OCIOs.

We request performance information in our RFPs, but it is a highly imperfect metric. Traditional investment consultants are not usually compliant with GIPS, and performance varies widely between clients due to varying investment policy restrictions, use of alternative assets, individual investment managers, and whether the client implements the consultant’s advice. Many firms provide us with representative account data, which may or may not be relevant to our client. Although some OCIOs invest client assets as a pool where it is very easy to show audited performance, customized OCIO providers face the same issues that traditional consulting firms do: clients have different investment restrictions, different managers, and different objectives.

That being said, as OCIO Strategic Investment Group recently said “Yes, OCIOs Can Be GIPS Compliant!”

What is GIPS Compliance?

GIPS is an established set of principles that standardize the calculation and reporting of investment performance. The GIPS standards are voluntary and based on the fundamental principles of full disclosure and fair representation of performance results. GIPS allows investment management firms to quantify and communicate their performance without misrepresentation. Reference the Global Investment Performance Standards Handbook from the CFA Institute for more information on the standards, which is available for download at the CFA website.

Any investment management firm can follow the guidelines set forth by GIPS when calculating its track record, but only firms that manage discretionary assets can claim compliance with GIPS. Compliance cannot be attained by a single product. A firm must follow all requirements of the GIPS standards across all of the firm’s products, or else it may not claim compliance. Moreover, each and every client must be included in one of the composites. The CFA Institute’s GIPS Standards website lists more than 1,500 firms who claim compliance. To date, few OCIOs are among them.

Why is GIPS Compliance Useful for OCIO Searches?

Simply put, an institution’s ability to judge the OCIO’s ability to beat their benchmark over time, with comfort that the numbers are not cherry-picked or massaged, is paramount in selecting a qualified OCIO. There are several complicating factors to consider, however.

Some OCIOs use “building blocks,” where they establish track records for asset class composites like global equity. Examining those records helps gauge skill in manager selection (and to some extent, the ability to combine managers). But what about asset allocation? Unfortunately, looking at building block records doesn’t show if an OCIO has skill in asset allocation, either strategic or tactical. A true GIPS composite gives the institution valuable insight into the ability of an OCIO to manage a total portfolio.

GIPS compliance also helps to compare firms on an “apples to apples” basis. In the searches Alpha Capital Management runs for large institutions, we receive performance information that is all over the map. Some firms send us gross numbers, many send us gross of their fee but net of the underlying manager fees, and very occasionally, we get “net-net” numbers (meaning net of underlying management fees AND net of any OCIO fees, representing the end client performance). GIPS would simplify this greatly.

Exhibit 1 shows a sample GIPS compliant presentation. It is clear why this is valuable. Not only does the recipient have performance information, but he also has key information necessary to verify the quality of the data going into that calculation.

There are some caveats. As discussed earlier, a firm claims compliance with GIPS. An individual strategy cannot be GIPS compliant; every strategy at the firm must be assessed and calculated in line with GIPS, and every account must be put into a composite. For OCIOs with asset management divisions, claiming GIPS compliance can be a very complicated, time consuming, and expensive endeavor. It also reduces a firm’s ability to be flexible in regards to how it shows performance, as it locks the firm into one set method of calculation (even for issues where GIPS allows some leeway, such as in the treatment of legacy client assets, the firm must choose a path and stick to it).

There are also many flavors of OCIOs. Some OCIOs offer significantly customized solutions across their client base, while others offer a single pooled investment strategy that all of their clients use. For the latter, GIPS compliance is much more straightforward than the former.

What are the Market Trends?

We’ve been loudly complaining about the lack of GIPS compliance by OCIOs for quite a long time. For reference, we wrote a piece last summer in which we remark, “it’s ironic that consultants who would never hire an investment manager without a track record ask to be hired without providing their own” (Outsourced CIO: Not a Silver Bullet). We can also point to a recent survey conducted by eVestment and ACA Compliance Group, which showed that three quarters of investment consultants will not consider managers that don’t claim compliance with GIPS for their performance data some or all of the time. (see FundFire's "No GIPS? No Mandate for Most Managers: Report" by Mariana Lemann from August 16, 2018)

In our own OCIO searches, our institutional clients have been focused on performance as a differentiator between firms, and they have been frustrated by the complexity of analyzing the data they receive. This issue matters to the institutional investors who allocate to OCIOs and have the power to demand transparency.

We believe that the client demand for transparency and comparability between providers will lead to GIPS standards being more widely adopted by OCIOs. We’re happy to see already that more OCIO firms are talking about GIPS compliance or making progress toward claiming compliance. Strategic Investment Group was an early adopter, as was Angeles Investment Advisors. Highland Associates and Aon recently announced GIPS compliance, and we have spoken to several other OCIOs or consulting firms who are in various stages of reviewing, calculating, or claiming compliance with GIPS.

We firmly believe that the industry will reach a “tipping point” where the major players are GIPS compliant, and competitors must follow their example to stay relevant. The move toward transparent, verifiable performance calculations is a great thing for investors, and we highly encourage it.

We applaud OCIO and consulting firms who have recognized this and are taking action. We hope to be able to exclude firms who do not claim compliance with GIPS or have audited numbers from our OCIO searches, but right now, there are not enough compliant firms to do so. As the OCIO industry develops, institutionalizes, and evolves, we think that adopting clear, verified standards of performance is the best possible way for institutions to differentiate between OCIO providers’ performance. We will do all we can to usher in this new era of transparency.

Why Hire a Search Consultant

Are you thinking of engaging a search firm to help you run a consultant search or OCIO search? You’re not alone. Although practically unheard of five years ago, the outsourced CIO (“OCIO”) model, in which a committee hires an investment manager to oversee the portfolio rather than soliciting advice from an investment consultant, has exploded onto the institutional landscape and has garnered significant interest from a wide range of institutions. The investment world has gotten increasingly complex, and more and more boards, committees, and organizations are unsure of their ability to truly fulfill their fiduciary obligation to the assets they oversee (at a time when fiduciary lawsuits are on the rise). OCIO models offer a solution for organizations struggling with a lack of internal resources, a desire to improve governance process, and the need to improve risk-adjusted returns. The traditional investment consulting model has evolved to fill these needs, but at the same time, it has complicated the investment advice landscape.

This added complexity has led to a new niche service provider: the consultant or OCIO search firm. These are sometimes referred to as “OCIO Search Consultants,” but we believe this terminology is confusing as consultants historically provide investment advice while OCIO search firms provide very targeted services to enable organizations to vet investment advice and implementation providers. We like to say, “don’t call us a consultant!” OCIO search firms exist to guide organizations through the search process, everything from designing the RFP and developing search criteria to identifying candidates and analyzing the responses. More than one-third (34%) of providers polled in a recent industry survey by Cerulli used a search firm, and this number continues to grow. They manage the entire project from start to finish, greatly simplifying this important fiduciary process for institutions.

Our Keys to a High Quality Search Firm

Lack of conflicts of interest

Independence - no OCIO or consulting services offered

Investment experience

Deep understanding of the industry

Ownership by key professionals

Ten Questions to Ask Search Consultants

It may seem silly to go through an RFP process to hire a firm to run your RFP process, but as a leading search firm, we often receive “mini-RFPs” with a handful of questions designed to compare us against our competitors. As RFP architects, it makes sense to us from a due diligence perspective. We encourage firms to consider this exercise, and to help, we compiled 10 sample questions that organizations can use to learn more about search firms.

Briefly describe your firm’s history and ownership structure.

Describe your core business focus.

What are the primary client types for which your firm provides consultant search services?

How many searches have you performed in the past 2 years and for what types of asset pools? Provide 3 references from recent searches.

Do you have any compensation agreements with any investment consultants, OCIOs, or money management firms that you include in searches? Are any such firms clients of your firm in any capacity?

Do you provide investment consulting or OCIO services to institutions?

Provide an overview of how you propose to lead our organization through the process, including identification of potential candidates, development of the RFP, and the review and evaluation of responses. Include a timeline.

Provide brief biographies of key professionals that would be responsible for working with our organization.

Describe your client service philosophy.

What are your competitive advantages? What are your limitations?

Want to see our answers? Email us to request our due diligence questionnaire.

Download a copy of our search consultant RFP to share with colleagues.

The tools you need to successfully project manage a search

There are plenty of logistics involved in executing an objective, documented process to search for an OCIO or investment consultant.

Generally, organizations and committees understand the basic process: find candidates, create a questionnaire that candidates fill out, read responses, select and interview finalists, and hire a new consultant. It’s all the tiny details and logistical issues that pop up as an organization goes through this process that cause problems!

In this blog post, Alpha Capital Management addresses some of the most common logistical questions we get from clients and potential clients. We break the process into three distinct phases: Design and Deliver, Analyze and Evaluate, and Select. Our hope is that this post gives your organization the tools it needs to successfully manage the search process, whether you outsource it to a search firm or do it yourself.

What happens first? Design and Deliver

When should our committee decide between OCIO and non-discretionary service models?As soon as possible! This is a hot topic, and most committees we work with are trying to answer the question of how much (if any) control to cede to their consultant. Are you looking for a partner or a money manager?We have seen clients push off this decision until later in the search process, choosing to run a hybrid search that includes full OCIO solutions, implemented consulting, and non-discretionary (traditional) consulting bids. This is certainly an option, but the service model does tend to keep dominating conversations throughout the search process, and the debate distracts from the ultimate goal of finding the best firm to provide the services that your organization needs.

We highly recommend that your committee spends time understanding and evaluating the different service models available BEFORE anything else happens. Once the committee has identified the best direction for the organization, the search process can proceed.

How should our committee identify candidates?Get references. Your recordkeeper, legal counsel, custodian, actuary, other service providers, and network of contacts at other organizations are good sources of consultant or OCIO referrals. Respected industry publications such as Greenwich Associates and Pensions and Investments (P&I) also publish lists of the major consulting and OCIO firms, which can provide a good starting point to research and identify candidates.

Keep in mind that firms tend to have areas of expertise and specialization – this may be corporate plans vs. endowment and foundations. Try to determine who has the most experience with your client type and what special resources they offer.

Should the finals date be set up front?Yes! We like to schedule two meetings as early as possible in the search process: the selection meeting (where RFP responses are discussed and final candidates are selected) and finals. It is very difficult to get the entire investment committee in a room at the same time, especially if this meeting is outside of the normal schedule – the easier you can make this process on all involved parties, the smoother it is likely to go.

We often add a “Timeline” section to the RFP so that candidates can also plan around this date, increasing the likelihood that all members of the proposed team can attend the finals presentations.

How much time do firms need to answer the RFP?Generally, we advise four weeks. This does depend on the length and complexity of the RFP. Keep in mind that consulting firms complete hundreds of RFPs and are quite practiced at it. We nonetheless try to give candidates six weeks to complete particularly complex RFPs.

What materials should our organization provide to candidates along with the RFP questionnaire?A list of required services as well as details on the portfolio are important for candidates to consider when crafting the proposal. The number and size of plans under consideration, frequency of committee meetings, spending policy (non-profits), if the pension plan is closed or frozen (retirement plans), and other key details should be included along with background information on your organization.

An important reason to go to RFP every 5-7 years is to fulfill governance best practices, including having outside firms review the investment policy statement (IPS) and portfolio asset allocation for completeness, alignment with current best practices, and ability to meet your organization’s goals. We provide the IPS and current asset allocation in nearly every search to elicit this valuable feedback.

How many questions should our RFP contain?More important than trying to hit a target number of questions is to make sure that the RFP asks for the information you need to compare candidates and select the best firm for your organization. If you don’t care about how a firm handles spending policy, don’t ask for that information. The best RFPs ask exactly as many questions as they need to compare consulting firms – and no more.

Our RFPs are usually about 100 questions. This, consultants tell us, is a lot. Many RFPs we see online and from other organizations have a lower number of questions, but those questions almost always have multiple parts. We find that the more parts a question has, the more likely it is that the candidate provides an incomplete response. This results in a lot of back-and-forth and wasted time. Instead of asking one question with five parts, we prefer to ask five one-part questions.

Should candidates be notified of all questions we receive throughout the process and their answers?In theory, this levels the playing field. In practice, we often don’t find it necessary as most of the questions and answers we get are not material – the caveat, of course, is that some processes (like those for public plans) require this. If several consultants ask the same clarifying question, we distribute the answer more broadly to candidates. And if we release new information to one firm, we release it to all firms.

What is a “quiet period,” and does our organization need one?This denotes a period of time after the RFP responses have been collected where candidates are not allowed to contact the organization. The goal of a “quiet period” is to avoid firms trying to influence the process – for example, a candidate wining and dining a committee member in an attempt to win the business. Similar to the last question about notifying all candidates of questions and answers, this is typically required by public plans and not used by others.

Analyze and Evaluate

Who should read the RFP responses?RFP responses with exhibits can range anywhere from 200-600 pages (or more). We once received a RFP that included a 4,000+ page Form ADV in addition to rest of the information and exhibits.

If your organization relies on a volunteer investment committee, or your committee is staffed with employees who have other pressing responsibilities, answering this question is often the most difficult part of the RFP. Search firms like Alpha Capital Management and our peers exist for clients who wish to outsource the project. For those who do it themselves, dividing the work among committee members or creating a sub-section of the committee assigned to read and summarize a few RFP responses each is likely your best option to ensure that it gets done. If the full committee is asked to review every single RFP response, you might find that no one does it!

How should we evaluate and score candidates?Hint: don’t wait until the RFP responses come back to answer this question. While writing the RFP, it is important to keep your evaluation criteria in mind to ensure that your consultant or OCIO RFP asks the right questions.

We recommend scoring candidates using a mix of quantitative and qualitative characteristics. We steer clear of highly formulaic scores. We also compare candidates relative to each other based on the needs of our client. No two clients focus on exactly the same things, so it makes sense to customize the scoring system.

Select

How many finalists should we select? Is the incumbent automatically invited?Three finalists seems to be the perfect number, though plenty of our clients end up with four. None (yet) have opted for two. Keep in mind that four candidates already makes for a very long day: four hours of presentations, one hour of breaks and lunch, and one hour for pre- and post-discussions. Five candidates would likely stretch to two days and feel quite repetitive. Clients who still have five candidates in mind at this stage in the project should further narrow the candidate pool. We’ve also had clients who elect to meet with several semi-finalists in an informal setting to get to know the firms in person before selecting finalists.

The incumbent is frequently, but not always, invited to present at the finals. It certainly isn’t a requirement, but it does help committees to have the current firm’s capabilities fresh in their minds while discussing competitors’ offerings.

How do we select the winner?By the final presentations, you have worked through a thorough, objective process to ensure the qualifications of each candidate and the strengths they bring to the table. The finals are your chance to evaluate the chemistry between your organization and the consulting team. It is also a great time to make sure the firm you select isn’t just good on paper.

After hearing each presentation, we recommend using a blind voting system to rank the candidates in order of preference to kick off the discussion.

Use the right tools to execute a successful OCIO search or investment consultant search

An RFP process doesn’t have to be a time-consuming, frustrating endeavor for you. Running successive searches for a wide variety of organizations, large and small, has helped us at Alpha Capital Management to develop a comprehensive process that can be executed in three to four months.

For the DIY organization, having the right people and processes in place at the outset saves a world of time and frustration. Good luck!

Want to download a copy of this post to share with colleagues? Find one here.

How do you solve the problem of an absentee investment committee?

With outsourced investment options (commonly called OCIO, which is how we’ll refer to these in the remainder of this report) becoming more popular in the institutional investment community, we have considered what types of governance issues an OCIO might be able to solve for organizations and investment committees.

This is not to say that OCIO is only useful for dysfunctional committees, but it is true that we usually get calls when something is broken. Sometimes this is related to the consultant: performance hasn’t met expectations, or the client feels that the consultant isn’t proactively managing the relationship, or perhaps there has been turnover on the account. But governance is also a key concern, and many of our clients and prospective clients have wondered if OCIO could solve a nagging problem: absentee investment committees.

Absentee committee member archetype

Having served on the boards of non-profits and having worked with many more as consultants and endowment directors, we understand this particular governance problem intimately. It can take many forms.

The serial volunteer: Bob’s biography proudly lists his participation on the boards of several well-known non-profits, but he rarely attends scheduled investment committee meetings and does not participate in most discussions or decisions.The dog ate my homework member: Susan attends scheduled committee meetings but has not done the background reading and preparation needed to add value to investment discussions; valuable meeting time is spent answering her questions.

The one whose cousin is a broker:Anita loves to bring new investment ideas to the table – unfortunately, most are either too expensive or too esoteric for the committee to invest in. They also have not been vetted by an independent consultant. Valuable time is wasted both for the committee and the investment consultant researching and rejecting these investments.

The pillar of the community:Anything Randall says goes, even if most of the investment committee thinks it is the wrong decision. After all, no one argues with Randall. He has been on the board for over ten years.

What all of these archetypical volunteers have in common is a tendency to distract the investment committee from its purpose. Too much time is wasted in valuable committee meetings, time that is needed to set the broad direction of the investment portfolio and monitor the service providers. You can’t force grown-ups to do their homework, especially not volunteers, but political considerations usually mean that organizations also cannot simply replace problem members.

Solutions for a thorny issue

There are several potential ways to handle this thorny issue, including:

Rely on the consultant’s advice while waiting out the terms of uncooperative committee members (not the most proactive way to handle it, but it does happen).

Bring in an external governance consultant to revamp the committee and put into place new policies and procedures.

Bring some committee responsibilities in house.

Outsource some or all of the committee‘s responsibilities to a third party.

Exploring Option 4 - OCIO

We’ve been asked, is there really a difference between effectively rubber stamping a consultant’s every recommendation and simply giving them discretion to make the decision?

In our minds, there are three primary differences:

1. The level of oversightAs with any industry and any firm, some investment consultants are more skilled than others. OCIOs should have policies and procedures in place where investment decisions are vetted and approved. This ensures that one consultant doesn’t “go rogue” or make decisions that don’t reflect the best thinking of the firm.

In the case of a traditional investment consultant relationship, there may not be the same level of consulting firm oversight – after all, the committee members are the additional level of oversight in the latter case. If the committee is not performing that level of oversight and simply takes all of the consultant’s recommendations on faith, a committee had better hope they have an A-team consultant guiding the portfolio!

The investment advisor, whether a non-discretionary consultant or OCIO, acts as a fiduciary alongside the investment committee, but the level of fiduciary responsibility differs. In an OCIO relationship, the committee does shift its fiduciary liability from evaluating the investments themselves to evaluating the advisor, but they must still fulfill this duty. The buck always stops with the committee.

3. The feeling of personal responsibilityAt the end of the day, a consultant who only provides advice may not feel personally responsible for the assets he or she advises on - especially if performance suffers when the consultant's recommendation is not taken. The level of responsibility is vastly higher for a named investment manager than it is for an advice provider. An investment manager lives or dies based on the results of his or her portfolio. A consultant, put simply, does not.

These distinctions tilt the scale in favor of absentee committees seriously considering OCIO solutions. However, it’s important to note that ultimately, this does NOT solve the tricky problem of a checked-out investment committee in our minds. Why not?

Who oversees the OCIO?

The committee retains the fiduciary duty to evaluate the OCIO provider, both initially and on an ongoing basis.To evaluate investment managers (and we include OCIOs here, as they effectively act as multi-asset managers for the portfolio) requires a specialized skill set. In fact, that’s one of the main services that an investment consultant provides in a traditional, non-discretionary consulting relationship.

Most investment committees include members with financial services experience or investment knowledge, often enough to set big-picture investment policy decisions and to weigh in on the long-term asset allocation of the portfolio. Investment committees are usually responsible for these tasks in either traditional non-discretionary or OCIO relationships, so we agree that this is the appropriate skill set to look for when selecting investment committee members. Unfortunately, this is not the same skill set required to perform in-depth due diligence on managers.

Investment committees who choose OCIO as a bandage, therefore, have not solved the initial problem of non-engagement, and they have created a higher bar for themselves in fulfilling their fiduciary duty.

The committee who was not fulfilling its previous fiduciary duty to evaluate investment managers based on advice given by a traditional investment consultant is not likely to suddenly start fulfilling this exact same role when it comes to evaluating the outsourced portfolio manager, the OCIO.

The committee must consider using an additional service provider in these situations: an investment expert who can perform an evaluation of the OCIO.

The value of a third-party OCIO evaluation

As outsourced investment solutions become more popular for institutions such as pension plans, endowments, and non-profit asset pools, so too do third-party evaluation and monitoring services who assist the investment committee in properly selecting and overseeing the OCIO.

These providers act as a “consultant” to the investment committee, assisting the committee in performing its crucial fiduciary responsibility of selecting, overseeing, and evaluating the outsourced investment solution. Typically, this review is performed annually and should be well documented. Just as OCIOs come in many flavors, so too do OCIO evaluation services. They range from truly independent advisors, who offer no institutional investment consulting or OCIO services of their own, to investment consultants and outsourced CIOs who serve in a monitoring capacity for non-investment clients.

We believe that there is great value in selecting a truly independent option, as consulting firms have a baked-in conflict of interest that can color the analysis. Just as the investment consultant should be providing advice independent of relationships with investment managers, monitors should provide advice independent of consultants.

For most institutions, running an investment consultant RFP or OCIO RFP is an occasional (and painful) process. There isn’t much value derived from previous RFPs since the intervals are too far apart. Offering this as a service, we have an opportunity to constantly improve and evolve our search process, including the questions in the RFP themselves. It allows us to pinpoint what works and what doesn’t. With that in mind, here are five of our favorites.

Update: we're pleased to announce that this report was featured in FundFire on December 15! Download your copy here.

Rationale: The lines have been blurred between investment managers, consultants, and outsourced chief investment officer (OCIO) providers – especially over the past few years. Although we typically include many questions in an RFP designed to identify potential conflicts of interest, this question gives us a birds-eye view of the firm’s revenue. We use it as a way to gauge the firm’s commitment to providing traditional consulting services versus OCIO services and/or investment management services. It also alerts us of existing business lines that we may not have captured in other questions and allows us to clarify this in conversations with the respondent.

2. What is the average client-to-consultant ratio at the firm, and how is it calculated?

Rationale: It was an investment consultant who clued us into the various ways this question can be answered. Some firms simply compare the number of clients to the number of investment professionals to calculate the ratio (thus including dedicated research professionals and support staff along with client-facing consulting professionals). Others only include consulting team members. One firm differentiated between lead (counted as 1 client) vs. co-lead (counted as 0.5 clients) relationships. In order to compare firms on this metric, it is important to get consistent responses and to understand how this metric is being calculated. We ask several questions about the client to consultant ratio, but this is the primary one we use for comparison.

3. Provide comments and suggestions on our current Investment Policy Statement (included with the RFP).

Rationale: What better way to evaluate a new advisor than to ask for advice in the RFP? When a new consultant is brought on board, the first step is often a review (and possibly, an overhaul) of the organization’s existing investment policy statement (IPS). Most of the time, these changes are cosmetic – for instance, a particular consultant may prefer wider bands around target allocations. But we have seen a few cases where prospective consultants identified potentially serious issues in a client’s IPS, including internal inconsistencies. Even if the organization stays with the incumbent, this question gives the organization comfort in the integrity of their IPS and documents a thorough review process with input from some of the best minds in the business.

4. How do you ensure best ideas are shared between consulting and research teams?

Rationale: The bigger the firm, the more likely it is that there are consultants and researchers spread across different departments and different geographic locations. The best research capabilities in the world won’t do a client any good if the consulting team isn’t receiving, processing, and funneling this information to the client. Ensuring that there are strong processes and procedures in place to keep these lines of communication open is a way of ensuring the client benefits from the full capabilities of the firm.

5. How do you measure your success as a consultant? Provide data as support.

Rationale: Much as our firm is constantly evolving and improving our RFP questions, consulting firms are evolving and improving their responses. They have carefully crafted qualitative answers to show off their skill set to the best of their ability. This question is a way for the client to quantify each firm based on the results of their advice (not an easy thing to do with consultants!). It also provides insight into what the consultants themselves think is important, which can be very helpful in setting criteria.

Bonus: Here's one that didn't work

Not all of our questions are successful in helping us to evaluate and differentiate between investment consultants. Here's one we tested out that didn't work very well:

What is the average client to senior consultant ratio for relationships in the following size ranges?A) Less than $100MB) $100M to $500MC) $500M to $1BD) $1B and greater

Rationale: Where questions are open to interpretation and gamification (such as the client to consultant ratio), we request different data points and ask for the information in different ways. This allows us to cross-reference the responses and ensure that the answers are consistent. We used this question (unsuccessfully) in a recent RFP.

We expected to see a higher client-to-consultant ratio on smaller clients (with AUM representing a crude measure of complexity) and a lower ratio on larger clients. Overall, the measure should be in line with the high-level client-to-consultant ratio.

The result?

40% of the firms we asked didn’t track this data and most of the rest didn’t provide consistent information in line with expectations. One firm, for example, came back with 1:1 in every category, which we believe signified one senior consultant assigned to each relationship (i.e. the consultant to client ratio, rather than vice versa).

Rather than try to reengineer this question, we simply removed it and rely on other measures to place the client to consultant ratio in context.

Outsourced Chief Investment Officer (“outsourced CIO” or “OCIO”) solutions have exploded in popularity in the past few years – although these types of relationships have existed for far longer. What is an OCIO? In the classic investment consulting relationship, an organization (for example, a corporation, government office, endowment, or foundation) works with a consultant to determine an appropriate policy and asset allocation for the investment pool. The investment consultant monitors the pool and advises on asset allocation changes, investment manager replacements, and other related issues. The organization retains discretion over the investment pool and may choose whether to follow the consultant’s advice; hence, these are “non-discretionary” relationships. In a discretionary (or OCIO) relationship, the consultant has the ability to implement changes without direct approval from the organization, acting as the chief investment officer.

As a consultant search service, we help organizations select investment consultants. These days, most clients ask about OCIO – even when the purpose of the search is to replace a non-discretionary investment consultant. Given the current level of attention OCIO commands in the news, it is not surprising. However, there is a significant amount of misinformation floating around the industry regarding outsourced CIO providers, and some carry a great deal of risk for organizations. OCIO is sometimes touted as a miracle cure or silver bullet. We hope to address some of the most common – and most dangerous – misconceptions in thinking about OCIO providers.

OCIO ABSOLVES AN ORGANIZATION OF ITS FIDUCIARY DUTYWe see this alluded to frequently in marketing materials from OCIO firms. Unfortunately, it is wrong. Nothing can release an organization (and by extension, a Board of Directors) from its fiduciary duty. Outsourced CIO providers can serve as co-fiduciary, but the organization remains a fiduciary for the investment pool. The organization also has the duty to evaluate the OCIO service provider on a regular basis, just as they have with a traditional consultant. It is tempting to turn things over to an OCIO and focus on other responsibilities (indeed, it’s one of the selling points of this service), but the organization puts itself at risk with this behavior.

OCIO IS A NEW SOLUTIONThis one is widespread but not particularly dangerous. OCIO has existed, under one name or another, for over twenty years. This type of arrangement is especially common in the endowment world, where investment teams broke away from larger endowments and created specialized investment models for use by small-to-mid-sized endowments and foundations. In recent years, however, the use of the “outsourced CIO” moniker has risen in popularity – and the number of firms offering these services has exploded. Even traditional investment consultants are getting into the space, with many now offering services along a spectrum from non-discretionary to full discretion.

OCIO FEES ARE SIMILAR TO TRADITIONAL CONSULTANTSAs with any business-to-business solution, price and service levels vary widely between firms. Fees for OCIO solutions are often two to three times more annually than a non-discretionary investment consultant. Given high dispersion and the lack of a standard service model, plan sponsors and institutions must carefully evaluate the costs involved and the services provided in each firm’s quote to fulfill their fiduciary duty. We recommend that organizations issuing an OCIO RFP request bids from a few firms who offer non-discretionary options (or both). This provides a benchmark when assessing fees.

OCIO PAYS FOR ITSELFAs we have just learned, OCIOs can cost significantly more than traditional investment consultants. One explanation for the difference is the level of service provided. OCIO providers like to say that it costs less to outsource than to build capabilities in-house. That depends. A 0.30% annual fee costs a $350M organization over $1M in fees per year, which could probably pay for an internal CIO, an assistant, and third-party investment research. Another justification OCIO firms use to downplay their fees is that outsourcing requires less support staff to implement investment changes (filing documents, initiating money transfers, etc.). In our experience, staff members spend only a fraction of their time on investment-related activities. Without proven investment results and measurable decreases in payroll, OCIO fees can prove hard for organizations to swallow.

OCIO FIRMS HAVE RESULTSPerformance is one way to draw clear comparisons between investment managers. Most investment managers, especially those who work with institutional clients, claim compliance with Global Investment Performance Standards (GIPS), a globally accepted methodology for calculating and presenting performance information. Prospective clients are able to directly compare investment manager results to measure skill. It’s ironic that consultants who would never hire an investment manager without a track record ask to be hired without providing their own.

Although we request performance information for representative client accounts in our non-discretionary and OCIO RFPs, it is hard to evaluate. Traditional consultants are not usually compliant with GIPS, and performance varies widely between clients due to varying IPS restrictions, use of alternative assets, individual investment managers, and whether the client implements the consultant’s advice. It seems that OCIO providers should clear this hurdle and be able to provide GIPS compliant performance (and there are some who do) – however, more customized OCIO providers face the same issues that traditional consulting firms do; clients have different investment restrictions, different managers, and different objectives.

OCIOS MINIMIZE CONFLICTS OF INTERESTMany OCIO firms (and traditional consulting firms) offer proprietary investment vehicles. These can take many forms, but a common one is an alternative fund-of-funds (for instance, private equity or hedge funds). These proprietary funds have potential benefits, including access to alternatives for smaller clients. But they also have potentially serious conflicts of interest. An OCIO firm has an incentive to invest clients in their fund-of-funds to earn more fees (if, for example, the fund includes performance incentives or management fees). In the private wealth world, this is known as double dipping, and the SEC takes it seriously. We have seen firms who rebate these fees back to their clients and others who do not. Investors need transparency into the layers of fees they pay to their OCIO providers as well as information on other potential conflicts of interest.

No solution is perfect for every client. With these misconceptions cleared up, our hope is that organizations can make the best decision to meet their needs, whether that is OCIO or non-discretionary consulting or something else entirely. OCIO is certainly not a silver bullet, but it can be a great weapon for an organization. Unsure if it is right for you? Interested in evaluating your options? Give us a call — we are happy to share our perspective.

We believe 2017 will go down as the year with the highest turnover of investment consulting relationships since the aftermath of the 2008 financial crisis. We assist institutions with investment consultant searches, so we have a ringside seat for the action, and we are amazed at the number of RFPs going out so far this year. One consulting firm we spoke with has already received double the amount of RFPs that they do in a typical year – and we aren’t even 6 months in. Considering that 20-30% turnover is normal in this business, this is a significant increase. Institutions are ready to make a change – but why now?

We have spoken to several consulting firms and institutions about this, and we have identified two major themes driving this uptick in activity.

THEME 1 : ALTERNATIVES-HEAVY PORTFOLIOS OUT OF FAVORAlternatives have become a common component of many institutional portfolios over the past several years, with hedge funds serving a key role. Given the complex nature of these alternative-heavy investment portfolios, consulting firms had a strong value proposition to offer these institutions: identify the top managers with intensive research and due diligence using the firms’ extensive resources. Hedge funds performed well in the 1990s and through the 2000-2002 downturn; in fact, many of the best fund managers became household names (Julian Robertson, George Soros, and their peers). Unfortunately, hedge funds did not hold up as well in the 2008 downturn, with the average fund down about 20%, and they have struggled ever since. With one large component of the portfolio seemingly out for the count, we have reached a tipping point for investment committees, organization staff, and plan sponsors to reevaluate their alternatives exposure – and with it, the consultants who recommended it.

THEME 2 : PASSIVELY MANAGED FUNDS OFFER CHEAPER, BETTER RESULTS THAN ACTIVE COUNTERPARTSIn institutional circles, popular media, and the private wealth space, active is out. Investors want results, and cheap, passively managed investments have delivered better results than expensive active managers in this market cycle. Institutions and their advisory boards have embraced passive management for many reasons, including lower fees but also continued political backfire from active investment performance. Yet we continue to meet with consulting firms that believe active management is the only way to go in a portfolio.

One argument we hear is that active management outperforms over long periods of time (8-10 years) thanks to superior downside protection. Unfortunately the tenure for most board members is shorter than this record-breaking bull market. The board is ultimately responsible for the welfare of the investment portfolio, and the financial and emotional toll of an all-active portfolio in this market environment is already high and keeps rising. Consulting firms that disregard the role of passive investments in a portfolio increasingly do so at their own peril.

KNOCKOUTOnly time will tell the winner as consulting firms continue to evolve in this new investment paradigm. Though these two themes dominate many conversations we have with investment committees and plan sponsors, the fact remains that governance best practice calls for a review of service providers every five to seven years regardless of performance. If you are interested in retaining an RFP consultant to guide you through the process, we would be happy to share our perspective.

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Authors

Brad Alford, CFAFounded Alpha Capital Management in 2006. 30 years of investment experience, including Managing Director of the Duke Endowment and Director of Endowment Investments for Emory.